Taxpayer and Commissioner of Taxation
[2013] AATA 783
[2013] AATA 783
Division TAXATION APPEALS DIVISION File Number(s)
2012/3748
Re
Taxpayer
APPLICANT
And
Commissioner of Taxation
RESPONDENT
DECISION
Tribunal Senior Member C R Walsh
Date 4 November 2013 Place Perth Decision Summary
The Tribunal affirms the decision under review.
..(Sgd) C R Walsh................
Senior Member C R Walsh
Catchwords
Income tax – deductibility of legal expenses – whether legal expenses incurred in challenging an ASIC banning order prohibiting taxpayer from providing any financial services for 5 year period in the Federal Court and in defending criminal charges for insider trading were incurred by taxpayer ‘in the course of’ gaining or producing assessable income – whether Federal Court legal expenses non-deductible capital expenditure – whether criminal charged legal expenses non-deductible private expenditure - whether private ruling relating to previous income years binding on Commissioner in relation to income year under review - whether taxpayer ‘employee’ - whether taxpayer’s position as stockbroker ‘suspended’ or ‘terminated’ - objection decision affirmed
Legislation
Administrative Appeals Tribunal Act 1975 – s 41(2)
Corporations Act 2001 – Division 5 of Part 7.6 - s 911A – s 916A – s 916B - s 920A(1) – s 920B(2) – s 1043A(1)(d) – s 1043A(2)(d)
Income Tax Assessment Act 1997 – s 8-1(1)(a) – s 8-1(2)(a) – s 8-1(2)(b)Taxation Administration Act 1953 – Part 5-5 of Schedule 1- s 359-20(2) – s 359-25(1) – s 357-60(1) – s 357-75(1) – item 2 of Table in s 357-75(1)
Cases
Amalgamated Zinc (De Bavay’s) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295
British Insulated & Helsby Cables Ltd v Atherton (1926) AC 205; 10 TC 15
Case 61/96, 96 ATC 570
Case N65, 81 ATC 335
Case V140, 88 ATC 875
Case X 84, 90 ATC 609
Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344
Commissioner of Taxation v Anstis [2010] HCA; (2010) 241 CLR 443
Commissioner of Taxation v Firth [2002] FCA 413; (2002) 120 FCR 450
Commissioner of Taxation v Rowe (1995) 60 FCR 99
Federal Commissioner of Taxation v Day [2008] HCA 53; (2008) 236 CLR 163
Federal Commissioner of Taxation v DP Smith 97 ATC 4553
Federal Commissioner of Taxation v Forsyth [1981] HCA 15; (1981) 148 CLR 203; 81 ATC 4157
Federal Commissioner of Taxation v Hatchett 71 ATC 4184
Federal Commissioner of Taxation v Kropp 76 ATC 4406
Federal Commissioner of Taxation v Payne 2001 ATC 4027
Federal Commissioner of Taxation v Wade [1951] HCA 56; (1951) 84 CLR 105
Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634
Healy v Commissioner of Taxation [2013] AATA 281
Jupiters Ltd v Deputy Federal Commissioner of Taxation 2002 ATC 4566
Lunney v Federal Commissioner of Taxation; Hayley v Federal Commissioner of Taxation (1958) 100 CLR 478
Maryborough Newspaper Co Ltd v Federal Commissioner of Taxation (1929) 43 CLR 450
Putnin v Commissioner of Taxation (1991) 27 FCR 50
Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation (1949) 8 ATD 431; (1949) 78 CLR 47
Schokker v Commissioner of Taxation [1999] FCA 600; (1999) 92 FCR 54
Sun Newspapers Ltd & Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87
Spriggs v Federal Commissioner of Taxation (2009) 239 CLR 1
Steele v Deputy Commissioner of Taxation [1999] HCA 7; (1999) 197 459
Vallambrosa Rubber Co Ltd v Farmer (1910) 5 TC 529
YYFM v ASIC [2009] AATA 409YYFM v ASIC [2010] AATA 340
REASONS FOR DECISION
Senior Member C R Walsh
4 November 2013
INTRODUCTION
In the year ended 30 June 2011, the Taxpayer incurred legal expenses totalling $83,056.63 (2011 Legal Expenses). The 2011 Legal Expenses comprised:
(i)$82,296.63, incurred in challenging a banning order made against the Taxpayer by the Australian Securities and Investments Commission (ASIC), on 4 February 2009, pursuant to ss 920A(1) and 920B(2) of the Corporations Act 2001 (Corporations Act), prohibiting him from providing any financial services for a 5 year period, in proceedings in the Federal Court and the Full Federal Court of Australia (Federal Court Legal Expenses); and
(ii)$760, incurred in defending 20 criminal charges laid against the Taxpayer by the Commonwealth Director of Public Prosecutions (DPP) on about 18 February 2011 in connection with 20 alleged contraventions of ss 1043A(1) and (2) of the Corporations Act, for insider trading (Criminal Charges Legal Expenses).
On 3 February 2012 the Taxpayer applied for a private ruling from the Commissioner regarding the deductibility of the 2011 Legal Expenses. On 3 May 2012 the Commissioner issued the Taxpayer with a private ruling in respect of the 2011 year which stated that the Taxpayer was not entitled to a deduction for the Federal Court Legal Expenses or the Criminal Charges Legal Expenses (2011 Private Ruling).
On 15 May 2012 the Taxpayer lodged his income tax return for the year ended 30 June 2011, returning taxable income of $367,984, primarily from share trading (2011 Return). Consistent with the 2011 Private Ruling, the Taxpayer made no claim for the 2011 Legal Expenses in the 2011 Return.
On 24 May 2012 the Commissioner issued the Taxpayer with an assessment for the year ended 30 June 2011, which assessed the Taxpayer’s taxable income for the year at $367,984 in accordance with the 2011 Return (Assessment).
On 20 June 2012 the Taxpayer objected to the 2011 Private Ruling. However, by correspondence between the Taxpayer’s representative and the Commissioner (dated 17 July 2012 and 23 July 2012) it was agreed that the Objection would be treated as an objection to the Assessment, and not as an objection to the 2011 Private Ruling (Objection).
On 23 July 2012 the Commissioner disallowed the Objection in full (Objection Decision) and on 24 August 2012 the Taxpayer applied to the Tribunal for a review of the Objection Decision.
BACKROUND
Part 7.6 of the Corporations Act contains provisions on the “Licensing of Providers of Financial Services”. A person who carries on a financial services business must hold an “Australian Financial Services Licence” (AFSL) covering the provision of financial services: s 911A of the Corporations Act.
Division 5 of Pt 7.6 of the Corporations Act contains provisions on “Authorised Representatives”. The term “authorised representative” (AR) is defined in s 716A of the Corporations Act as a person authorised, in accordance with ss 916A or 916B of the Corporations Act, to provide a financial service or financial services on behalf of the holder of an AFSL.
The Taxpayer has worked in the financial services industry since April 1997, initially employed by Merrill Lynch Australia as a private client adviser.
The Taxpayer was later employed as a stockbroker for Salomon Smith Barney Australia Pty Ltd, later known as Citigroup Wealth Advisors Pty Ltd (Citigroup), between about 20 May 2002 and 23 March 2007.
In early 2007, ASIC commenced an investigation into alleged insider trading offences by the Taxpayer, involving alleged contraventions of s 1043A(1) and (2) of the Corporations Act.
On 23 March 2007 the Taxpayer purported to resign from his employment with Citigroup. However, on the same day, Citigroup terminated the Taxpayer’s employment with it.
On 23 April 2007 the Taxpayer entered into an Authorised Representative Agreement (ARA) with Indian Ocean Capital Pty Ltd (IOC) (now CPS Capital Group Pty Ltd (CPS Capital)), the holder of an AFSL, to provide stock broking services as an AR on behalf of IOC in accordance with the ARA.
The ARA provided, among other things, that:
· the Taxpayer was authorised as an AR to provide certain financial services (called “Authorised Services”) in relation to certain derivatives and securities (called “Authorised Products”) on behalf of IOC: cl 2.1 of the ARA.
· the Taxpayer’s authorisation commenced on 23 April 2007 and continued until suspended or revoked by IOC in accordance with cl 2.10 of the ARA or until the ARA was terminated in accordance with cl 13 of the ARA: cl 2.2 of the ARA;
· the relationship between IOC and the Taxpayer was not one of “employment”: cl 4 of the ARA; and
· the Taxpayer was entitled to commission only: cl 11.1 and cl 11.5 of the ARA.
On 4 February 2009, ASIC made a banning order against the Taxpayer under ss 920A(1) and 920B(2) of Division 8 of the Corporations Act, prohibiting him from “providing any financial services for a period of five years” (ASIC banning order). The ASIC banning order was a result of the investigation commenced by ASIC in early 2007: refer to paragraph 11 above.
On 11 February 2009 the Taxpayer applied to this Tribunal for a review of the ASIC banning order and, on 6 March 2009, the Tribunal made an order pursuant to s 41(2) of the Administrative Appeals Tribunal Act 1975 staying the operation of the ASIC banning order until the Tribunal had determined the Taxpayer’s application for review, or further order: YYFM v ASIC [2009] AATA 409.
On 30 June 2009 the Tribunal ordered that any further hearing of the application for review be stayed until further order, subject to the Taxpayer providing a written undertaking in terms acceptable to the Tribunal as to the manner in which the Taxpayer would provide any financial services during the period of the stay.
No written undertaking in terms acceptable to the Tribunal was provided by the Taxpayer, but the stay order of 30 June 2009 remained in place and the application for review of the ASIC banning order was heard by the Tribunal on 11 December 2009.
On 7 May 2010 the Tribunal affirmed ASIC’s decision to make the ASIC banning order and revoked the previous stay order: YYFM v ASIC [2010] AATA 340. As a result, the ASIC banning order became effective on 7 May 2010.
Section 916A(3) of the Corporations Act provides that an AR’s authorisation is “void” to the extent that it purports to authorise a person to provide a financial service contrary to a banning order made under Division 8 of the Corporations Act. Consequently, the Taxpayer’s authorisation as an AR with IOC became “void” on 7 May 2010.
On or about 18 May 2010 the Taxpayer lodged an appeal to the Federal Court of Australia from the Tribunal’s decision of 7 May 2010.
On 4 June 2010 the Federal Court declined to order any further stay of the operation of the ASIC banning order and the appeal was set down for hearing.
On 13 August 2010 the Federal Court dismissed the Taxpayer’s appeal from the Tribunal’s decision of 7 May 2010.
On 1 September 2010 the Taxpayer applied to the Commissioner for a private ruling on the deductibility under s 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) of legal expenses incurred by him in the income years ended 30 June 2009 and 30 June 2010 in connection with the application to the Tribunal for review of the ASIC banning order.
On 3 September 2012 the Taxpayer appealed the Federal Court’s decision of 13 August 2010 to a Full Court of the Federal Court of Australia.
On 9 November 2010 the Commissioner issued the Taxpayer with a private ruling on the deductibility under s 8-1 of the legal expenses incurred by him in the income years ended 30 June 2009 and 30 June 2010 (2009/2010 Private Ruling).
The 2009/2010 Private Ruling stated that the Taxpayer was entitled to claim a deduction under s 8-1 of the ITAA 1997 for legal expenses incurred in reviewing the ASIC banning order but was not entitled to claim a deduction under s 8-1 of the ITAA 1997 for legal expenses incurred in action taken by the applicant to have his name withheld in the subsequent proceedings to review the ASIC banning order.
On or about 18 February 2011, 20 criminal charges were laid against the Taxpayer by the DPP in connection with 20 alleged contraventions of ss 1043A(1) and (2) of the Corporations Act for insider trading. These charges resulted in a jury trial in the Supreme Court of Western Australia during 27 February 2013 and 19 March 2013. The Taxpayer was acquitted on 17 of the 20 of the charges laid. The jury was undecided on the 3 remaining charges which were subsequently withdrawn by ASIC.
On 11 March 2011 the Full Federal Court dismissed an appeal by the Taxpayer from the decision of the Federal Court of 13 August 2010.
2009/2010 Private Ruling
In the “Applicant’s Statement of Facts & Contentions,” dated 19 July 2013 (Taxpayer’s SFC), at [30], the Taxpayer contends that:
…..having ruled [in the 2009/2010 Private Ruling] that legal fees incurred [by the Taxpayer] in the 2009 and 2010 in respect to the [ASIC banning order] were deductible,.…..the Commissioner of Taxation is precluded from adopting a different position in relation to legal fees incurred [by the Taxpayer] on the same matter in the 2011 tax year.
A similar submission was made by counsel for the Taxpayer in opening.
With respect, this contention is misconceived. Applying the “Rulings” provisions contained in Part 5-5 of Schedule 1 of the Taxation Administration Act 1953 (TAA), there are several reasons why the 2009/2010 Private Ruling is not binding on the Commissioner in relation to the 2011 year.
First, the 2009/2010 Private Ruling was for a specified “scheme” arising in the 2009 and 2010 years: s 359-20(2) of the TAA. The question of the deductibility of the 2011 Legal Expenses took place in a different factual context to the 2009 and 2010 legal expenses on which the 2009/2010 Private Ruling was based.
Second, a private ruling may specify the time from which it begins to apply and the time at which it ceases to apply: s 359-25(1) of the TAA. The 2009/2010 Private Ruling specified that it ceased to apply at the end of the year ended 30 June 2010. As such, the 2009/2010 Private Ruling does not apply to the year ended 30 June 2011.
Third, a private ruling binds the Commissioner in relation to a particular taxpayer if the ruling applies to the taxpayer and the taxpayer acts in accordance with the ruling: s 357-60(1) of the TAA. Here, the Taxpayer did not act, in terms of s 357-60(1) of the TAA, in accordance with the 2009/2010 Private Ruling in relation to the 2011 Legal Expenses. Rather, he sought a separate ruling in relation to the deductibility of the 2011 Legal Expenses. As such, it cannot be said that the Taxpayer was acting in reliance on the 2009/2010 Private Ruling as regards the deductibility of the 2011 Legal Expenses.
Fourth, even if, which the Tribunal does not accept, the 2009/2010 Private Ruling is binding on the Commissioner (and, thus, applicable to the Taxpayer) then pursuant to the “inconsistent rulings” provision in s 357-75 of the TAA, since the Taxpayer informed the Commissioner of the 2009/2010 Private Ruling in the course of seeking the 2011 Private ruling, the 2009/2010 Private Ruling “is taken not to have been made”: item 2 of the Table in s 357-75(1) of the TAA.
In any event, it is well established that no conduct on the part of the Commissioner can operate as an estoppel against the operation of the taxation legislation: Federal Commissioner of Taxation v Wade [1951] HCA 56; (1951) 84 CLR 105 at 117.
ISSUES
It is not in dispute that the 2011 Legal Expenses were “incurred” by the Taxpayer in the year ended 30 June 2011 for the purpose of the first positive limb of the general deduction provision in s 8-1of the ITAA 1997.
What is in dispute, and what must be decided by the Tribunal, is whether the Taxpayer is entitled to a deduction under s 8‑1 of the ITAA 1997 for the Federal Court Legal Expenses and the Criminal Charges Legal Expenses incurred by him in the 2011 income year and thus whether the Assessment is excessive.
RELEVANT LAW & ANALYSIS
Relevant to this application is the first positive limb of the general deduction provision in s 8-1(1)(a) of the ITAA 1997. Legal expenses, like any other loss or outgoing, are deductible under s 8-1(1)(a) to the extent that they are incurred “in gaining or producing” assessable income. However, legal expenses are not deductible to the extent that they are capital or private in nature: s 8-1(2)(a) and (b) of the ITAA 1997.
Whether legal expenses have been incurred in gaining or producing assessable income is a question of fact and degree: Maryborough Newspaper Co Ltd v Federal Commissioner of Taxation (1929) 43 CLR 450 at 452-453 per Rich J and Federal Commissioner of Taxation v Forsyth [1981] HCA 15; (1981) 148 CLR 203 at 213; 81 ATC 4157 at 4163 per Wilson J. Accordingly, whilst previous decisions on the deductibility of legal expenses, such as Putnin v Commissioner of Taxation (1991) 27 FCR 508, Commissioner of Taxation v Rowe (1995) 60 FCR 99, Schokker v Commissioner of Taxation [1999] FCA 600; (1999) 92 FCR 54 and Federal Commissioner of Taxation v Day [2008] HCA 53; (2008) 236 CLR 163, may be instructive, they are not binding.
It is well established that the words in s 8-1(1)(a) of the ITAA “incurred in gaining or producing your assessable income” are to be read as meaning “incurred in the course of gaining or producing your assessable income”: Amalgamated Zinc (De Bavay’s) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295 at 303 per Dixon J, Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation (1949) 8 ATD 431; (1949) 78 CLR 47 at 57, Federal Commissioner of Taxation v Payne 2001 ATC 4027 at 4030 and Day (2008) 236 CLR 163 [30].
The relevant question is whether the outgoing was incurred “in the course of” gaining or producing actual or expected income. That is, one must ask: is the occasion of the outgoing found in whatever is productive of actual or expected income?: Ronpibon Tin NL (1949) 78 CLR 47 at 57 and as re-stated by the High Court in Payne 2001 ATC 4027 at 4030 and, more recently, in Day (2008) 236 CLR 163 at 179-180 [30] and [31], Spriggs v Federal Commissioner of Taxation (2009) 239 CLR 1 and Commissioner of Taxation v Anstis [2010] HCA 40; (2010) 241 CLR 443.
The words in s 8-1(1)(a) require more than a mere causal connection between the expenditure and the derivation of income. What must be shown is a closer and more immediate connection: see Day (2008) 236 CLR 163 at 176 [22], referring to Payne 202 CLR 93 at 101 [13]. The relevant inquiry is how the assessable income was or was expected to be gained or produced: Day (2008) 236 CLR 163 at 179 [31] and Anstis (2010) 241 CLR 443 at 456 [30].
The subjective purpose for incurring the loss or outgoing is not determinative to the inquiry. Rather, in most cases the objective relationship between the expenditure and that which is productive of income will provide a sufficient answer to the inquiry: Day (2008) 236 CLR 163 at 183 [39] and Anstis (2010) 241 CLR 443 at 456 [31]. An objective approach is all the more appropriate where, as here, the expenses concerned are involuntary: Putnin v Commissioner of Taxation (1991) 27 FCR 508 at 512-513.
It is well established that to claim a deduction for a loss or outgoing under s 8-1(1)(a) of the ITAA 1997, it is necessary to establish some “link” or “nexus” between the loss or outgoing and the production of assessable income, often sometimes referred to as a “sufficient connection”.
The courts have adopted various tests to determine whether the necessary “sufficient connection” exists in a particular case, such as the “perceived connection” test (Federal Commissioner of Taxation v Hatchett 71 ATC 4184 at 4187 per Menzies J and Federal Commissioner of Taxation v Kropp 76 ATC 4406 at 4411), the “incidental and relevant” test (Ronpibon Tin (1949) 78 CLR 47 at 56) and the “essential character” test (Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344 and Lunney v Federal Commissioner of Taxation; Hayley v Federal Commissioner of Taxation (1958) 100 CLR 478). These tests are summarised by Hill J in Commissioner of Taxation v Firth [2002] FCA 413; (2002) 120 FCR 450 [6] as follows:
The positive tests require that there be a connection between the loss or outgoing on the one hand and the assessable income or business on the other. The nature of that connection has been expressed in different ways in the cases. It is sometimes said that there must be a ‘perceived connection’ between the loss or outgoing and the assessable income or business……...in other cases it has been said that the expenditure must be ‘incidental and relevant’ to the operations or activities regularly carried on by the taxpayer for the production of income………These ways of describing the connection that is a necessary prerequisite to deductibility are but part of the process of identifying the essential character of the expenditure in order to determine whether a particular loss or outgoing is in fact incurred in gaining or producing assessable income….[Emphasis added & citations omitted]
Before turning to consider the deductibility of the 2011 Legal Expenses, there are two preliminary disputed factual issues which require clarification.
The first is whether the Taxpayer was “employed” by IOC (i.e. whether their relationship was one of employer/employee). This issue arises because of the use of the words “employed” and “employment” in some of the material filed with the Tribunal by the Taxpayer.
However, by his own admission, the Taxpayer was not an “employee” of IOC. The Taxpayer’s Witness Statement, dated 2 September 2013, states:
15.My engagement with IOC was solely to provide the services set out under the ARA as a representative. I was not an employee of IOC (see clause 4 of the ARA), and I was not engaged to provide any other services to IOC such as administration or management.
Further, the “Applicant’s Reply Submissions”, dated 11 October 2013, addresses this concern (at [5]) as follows:
……….In the material before the Tribunal at the hearing it was not asserted by the applicant or by Mr [X], that the applicant was in the employment of IOC after the banning order became effective on 7 May 2010. The applicant was never in the paid or unpaid employment of IOC and could not be under the terms of the ARA, see clause 4. Under the ARA the applicant provided stockbroking services to IOC as an authorised representative for broking commissions. [Emphasis added]
The second preliminary disputed factual issue is whether Taxpayer’s appointment as an AR of IOC was “terminated”, or merely “suspended”, when the ASIC banning order became operative on 7 May 2010. The Taxpayer’s contention is that his position as an AR of IOC was merely “suspended” on 7 May 2010, when the ASIC banning order became operative. In contrast, the Commissioner asserts that the Taxpayer’s position as an AR of IOC was “terminated” on 7 May 2010, when the ASIC banning order became operative. The significance of this in terms of the deductibility of the 2011 Legal Expenses under s 8-1(1)(a) of the ITAA 1997 is discussed later below.
In this regard, the Taxpayer’s SFC states (at [3] and [4]) that the Taxpayer “remains in employment with [IOC], albeit on an unpaid leave of absence” and that his “employment [with IOC] has not been terminated and that [he] and [IOC] are in agreement that once the [ASIC banning order] is lifted, he will return to paid employment” at IOC: Taxpayer’s SFC at [3] and [4]. Further, counsel for the Taxpayer opened on the basis that a continuing working arrangement between the Taxpayer and IOC would be proved.
Both the Taxpayer and Mr X described the Taxpayer’s stockbroking services as being “suspended” by agreement, rather than as being “terminated”, as a consequence of the ASIC banning order becoming operative on 7 May 2010. This agreement, it was said by both the Taxpayer and Mr X, was reached some time after ASIC made the ASIC banning order on 4 February 2009 but before it became effective on 7 May 2010, and continues to this day, pending the ASIC banning order being lifted or expiring.
In his Witness Statement, dated 2 September 2013, the Taxpayer states at [31]:
Shortly after ASIC issued the Banning Order, I agreed with IOC that my services under the ARA be suspended until the results of a stay application against the Banning Order made shortly after it’s (sic) imposition was given by the Tribunal, or, in the absence of a successful stay application, when the Banning Order was overturned or until after the expiration of the 5-year ban. After the suspension was lifted and provided there was no ASIC encumbrance on my ability to provide the Authorised Services, it was agreed that I would return to my work for IOC on either the same or similar terms as the ARA. I do not recall the exact date of this agreement but the discussion agreement occurred within a few days of the issue of the Banning Order. [Emphasis added]
Similarly, in his Witness Statement, dated 2 September 2013, Mr X, a director of IOC (now CPS Capital), states (at [12]) that the Taxpayer’s position at IOC was merely “suspended” upon the ASIC banning order coming into effect.
However, at paragraph 11 of his Witness Statement, Mr X refers to the “termination” of the Taxpayer’s position at IOC. Further, in a letter to the Taxpayer, dated 9 February 2009, Mr X stated:
I refer to our discussion on Monday 9 February 2009 during which you informed me about the decision made by…..ASIC to ban you from providing any financial services for a period of 5 years.
Accordingly, I am given no choice but to suspend you immediately forthwith.
You also told me that you intend seeking a review of [ASIC’s] decision by the AAT, and are also seeking a stay of the banning order until the determination of that review.
This is to advise you that should you be unsuccessful in obtaining a stay of the [ASIC] banning order, we will have no alternative but to terminate your employment immediately, because all positions here require the employee to hold a proper authority. [Emphasis added]
The above letter was sent by Mr X to the Taxpayer at about the time that the alleged “suspension” agreement was entered into by the Taxpayer and Mr X. The letter states unequivocally that the Taxpayer was to be “terminated” from his position as an AR of IOC (rather than “suspended”) if he was unsuccessful in obtaining a stay of the ASIC banning order.
The Tribunal considers Mr X’s letter to the Taxpayer dated 9 February 2009, to be the best evidence of what was discussed by and agreed between the Taxpayer and Mr X at the relevant time. On this basis, and for the following additional reasons, the Tribunal is not satisfied that throughout the year ended 30 June 2011 year the Taxpayer’s position at IOC was merely “suspended” and finds instead that it was “terminated”:
· in cross-examination, the Taxpayer accepted that the 9 February letter set out what was “agreed” between him and Mr X;
· the Taxpayer’s evidence regarding the alleged “suspension” agreement was vague and unsatisfactory. Initially, the Taxpayer said that the alleged “suspension” agreement was made in 2010 but, after being directed in cross-examination to what was stated in his Witness Statement, dated 2 September 2013, he said that agreement was in fact made in February 2009;
· the Taxpayer’s unsolicited evidence that he did not socialise with Mr X was directly contradicted by Mr X;
· in cross-examination, the Taxpayer accepted that his role as an AR with IOC ceased upon the ASIC banning order becoming operative on 7 May 2010, that he ceased “employment” with IOC on 7 May 2010 and that in the 2011 income year he did not have a stockbroking job with IOC;
· in cross-examination, Mr X disavowed the suggestion that the Taxpayer was merely “suspended” and accepted that the Taxpayer’s status as an AR with IOC was “terminated” with effect from 7 May 2010; and
· in re-examination, Mr X said:
The understanding between [IOC] and [the Taxpayer] was that there is no facility for me to suspend him as an [AR]. You are either appointed or you are terminated….we had to terminate him because of law…
· the Taxpayer’s evidence as to the alleged “suspension” agreement was inconsistent with his prior affidavit evidence in the earlier Tribunal proceedings. For example, the Taxpayer informed the Tribunal in an affidavit, sworn 11 February 2009, that:
12.I have been informed by my employer, [IOC], that unless I am successful in obtaining a stay of the banning order pending the determination of my application for review of the Decision, they will terminate my employment…
and, in cross-examination, the Taxpayer said that the above passage was true;
· the alleged “suspension” agreement contradicts what the Taxpayer told the Australian Government Solicitor in his February 2013 “chronology”. There, the Taxpayer said that he “ceased employment” with IOC on 7 May 2010 upon the Tribunal dismissing his application for review of the ASIC banning order. In cross-examination, the Taxpayer said that the contents of the chronology was correct and later conceded that he “ceased employment” on 7 May 2010;
· the alleged “suspension” agreement is inconsistent with the ASIC records which state that the Taxpayer’s status as an AR ceased with effect from 7 May 2010. In cross-examination, Mr X explained that he personally effected the Taxpayer’s change of status, by amending ASIC’s records on-line, and did so because the Taxpayer’s role as an AR with IOC ceased upon the ASIC banning order becoming operative on 7 May 2010; and
· the alleged “suspension” agreement is contrary to IOC’s own records, where the office manager refers to the Taxpayer’s position as an AR as terminating on him leaving on 7 May 2010.
Deductibility of 2011 Legal Expenses
The Taxpayer’s main contention is that the “occasion” of his outgoings in the 2011 year was “defending activities he was undertaking in the course of earning his income as a stockbroker and provider of financial services between 12 July 2006 and 9 August 2006” and that his expenditure in the 2011 income year “was a continuing part of an ongoing defence of those actions”: “Applicant’s Written Submissions”, dated 27 September 2013, at [36] and [43].
According to the “Applicant’s Written Submissions”:
44.This is not a case of incurring outgoings to obtain employment…….the occasion of the continuing legal expense outgoing is found in the [Taxpayer’s] income earning activities.
45.Since 4 February 2009 the applicant has involuntarily expended money on legal expenses challenging the ASIC banning order on him providing legal services. The applicant was incurring this expenditure for no other reason than to gain or produce expected assessable income. The objective relationship between the legal expenses and the scope of the ongoing work which produces assessable income answers the inquiry that the expenditure was incurred in gaining and producing assessable income and was not a private expense or an expense on capital account.
Similar submissions were made throughout the Taxpayer’s SFC at [34] – [36], [39], [41], [44], [49] – [52] and [55].
The Taxpayer’s argument for the deductibility of the 2011 Legal Expenses relies on, by analogy, earlier decisions concerning the deductibility of legal expenses such as Putnin, Rowe, Schokker and, in particular, Day.
Day was a case which involved a suspended employee, a Commonwealth public servant, facing disciplinary proceedings which might have exposed him to dismissal or a loss of salary. In Day the Court held that the legal expenses incurred by the employee in defending the charges against him were properly allowable as deductions under s 8-1 of the ITAA 1997. In reaching its conclusion, the plurality of the Court stated:
The respondent’s position as an officer subject to the Public Service Act 1922 obliged him to observe standards of conduct extending beyond those in the performance of tasks associated with his office and exposed him to disciplinary procedures within the Service which might have consequences for the retention of his office or his salary: 236 CLR 163 at 182 [37]. [Emphasis added]
The respondent’s outgoings, by way of legal expenses, followed upon the bringing of the charges with respect to his conduct or misconduct, as an officer. He was exposed to those charges and consequential expenses, by reason of his office. The charges cannot be considered as remote from his office, in the way that private conduct giving rise to criminal or other sanctions may be: 236 CLR 163 at 182-183 [37]. [Emphasis added]
The respondent’s duties as an officer of the Service, and the possible consequences to him of internal disciplinary proceedings and action with respect to the continuation or termination of his service, form part of what was productive of his assessable income in that capacity. Applying the inquiry as to connection posed by the section, as explained by Ronpibon Tin, the occasion of the legal expenses is to be found in his position as an officer. It follows that the expenses were properly allowable as deductions: 236 CLR 163 at 184 [40]. [Emphasis added]
In Day, the taxpayer’s duties as an officer of the public service, and the potential consequences to him of internal disciplinary proceedings and action with respect to the continuation or termination of his “employment” with the public service, formed part of what was productive of his assessable income in that capacity. As the “occasion” of the taxpayer’s legal expenses was to be found in his “employment” position, the legal expenses were found by the Court to be deductible.
It is important to remember that in Day the Court was concerned with what was productive of an “employee’s” income in a particular context. That is, Day does not lay down any rule for the deduction of legal expenses by an employee, beyond the general requirement that the occasion for the expenses must be found in what is productive of the assessable income of the employee. This requires a consideration of the scope of the taxpayer’s employment arrangements and is ultimately a question of fact and degree. In this regard, in Day, the plurality of the Court stated (at 236 CLR 163 at 183 [38]):
It was necessary for the respondent to obtain legal advice and representation in order to answer the charges and to preserve his position……..The incurring of the expenditure by an employee to defend a charge because it may result in his or her dismissal may not itself be sufficient in every case to establish the necessary connection to the employment or service which is productive of income. Much will depend upon what is entailed in the employment and the duties which it imposes upon an employee….
Unlike the taxpayer in Day, who had an on-going employment relationship with his employer (the public service), here, the Taxpayer’s position as an AR of IOC ceased, was “terminated”, on 7 May 2010 before the 2011 Legal Expenses were even incurred by him. In the Tribunal’s opinion, the connection between the 2011 Legal Expenses incurred by the Taxpayer and the production of assessable income rises no higher than a mere “causal connection” and, as discussed above, the authorities make it clear that a mere “causal connection” in insufficient for s 8-1(1) purposes. Something closer and more immediate than a mere causal connection is required: see paragraph 44 above.
Federal Court Legal Expenses
In relation to the Federal Court Legal Expenses specifically, the Tribunal considers that the “occasion” for and “essential character” of those expenses was to enable the Taxpayer to re-enter the regulated stockbroking/financial services industry, whether that be with IOC or another stockbroking firm/financial service provider (with an AFSL): Ronpibon Tin NL, Payne, Day, Spriggs, Anstis, Charles More, Lunney and Firth. As discussed, the ASIC banning order prohibited the Taxpayer from “providing any financial services for a period of five years” and the consequences of the ASIC banning order becoming operative on 7 May 2010 were that the Taxpayer’s authorisation as an AR became “void” (under s 916A(3)(b) of the Corporations Act) and his position as an AR of IOC was “terminated”. However, more than that, the effect of the ASIC banning order becoming operative was that the Taxpayer could no longer provide any financial services for any stockbroking firm/financial services provider (with an AFSL) for a five year period, whether that be IOC or a different firm/provider.
In such circumstances, it cannot be said that the “occasion” of the Federal Court Legal Expenses is to be found in his position as an AR of IOC (cf Day) and in what is productive of the Taxpayer’s assessable income: Ronpibon Tin NL, Payne, Day, Spriggs and Anstis. The “occasion” for the Federal Court Legal Expenses is not to be found in the Taxpayer’s position as and AR of IOC, being a position he no longer occupied when the Federal Court Legal Expenses were incurred. In no meaningful sense, were the incidents or requirements of any employment relationship, or the office of AR, the “occasion” or reason for the incurring of the Federal Court Legal Expenses: cf Day. Consequently, the Tribunal considers that there is an insufficient “connection” (“link” or “nexus”) between the Federal Court Legal Expenses and the production of assessable income by the Taxpayer: see cases referred to in paragraph 47 above. It follows that the Taxpayer is not entitled to a deduction for the Federal Court Legal Expenses as they were not incurred by him “in the course of” gaining or producing assessable income for the purposes of s 8-1(1)(a) of the ITAA 1997.
It only becomes necessary to consider the exceptions to s 8-1(1) of the ITAA 1997, in s 8-1(2) of the ITAA 1997, if it has already been concluded, or accepted by hypothesis, that one of the positive limbs in s 8-1(1) applies: Steele v Deputy Commissioner of Taxation [1999] HCA 7; (1999) 197 CLR 459 [24]. However, for completeness, the Tribunal makes the following observations regarding the capital nature of the Federal Court Legal Expenses.
Even if the Tribunal found that the Federal Court Legal Expenses were deductible under the first positive limb in s 8-1(1)(a) of the ITAA 1997, which it did not, it would have nevertheless found the Federal Court Legal Expenses to be non-deductible capital expenditure under s 8-1(2)(a) of the ITAA 1997. The reasons for this are as follows.
The courts have formulated a number of indicia to determine whether a loss or outgoing is “capital”, as opposed to “revenue” in nature, including whether the expenditure: (i) relates to the “profit yielding structure” (Sun Newspapers Ltd & Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 at 359-360 and 363; 5 ATD 87); (ii) is recurrent or “once and for all expenditure” (Vallambrosa Rubber Co Ltd v Farmer (1910) 5 TC 529 at 536); (iii) is for an “enduring benefit” (British Insulated & Helsby Cables Ltd v Atherton (1926) AC 205; 10 TC 15); and (iv) is capital, and not revenue, in an “economic sense” (Federal Commissioner of Taxation v DP Smith 79 ATC 4553). The starting point in determining whether legal expenses are capital in nature are capital in nature, is to consider the reason for which the legal expenses have been incurred: Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 at 647 per Dixon J. One must ask: what are the legal expenses really for and, then, are the legal expenses for, in truth and in substance, a capital asset?: Jupiters Ltd v Deputy Federal Commissioner of Taxation 2002 ATC 4566.
Legal expenses associated with defending registration to practise a profession are usually considered non-deductible as they relate to the “profit-yielding structure” and are “capital” in nature: see Case X 84, 90 ATC 609 and Case 61/96, 96 ATC 570 (which cases involved doctors incurring legal expenses in defending de-registration proceedings), Case N65, 81 ATC 335 (which case involved a pharmaceutical chemist incurring legal expenses in defending the cancellation of his pharmacist’s registration) and Case V140, 88 ATC 875 (which case involved a solicitor incurring legal expenses on proceedings resulting in a suspension from practice). In each of these cases, the Tribunal found the relevant legal expenses to be non-deductible “capital” expenditure on the basis that the expenditure concerned:
· had been incurred in resisting the threatened extinction of the profit yielding structure, being the right to practice medicine (Case X 84);
· was to protect an enduring benefit (Case 61/96);
· had the character of an outgoing in the course of maintaining or preserving the taxpayer’s business, rather than that of a working expense (Case N65); and
· was for defending or acquiring structural, capital, assets (Case V 140).
In this case, the Tribunal considers that the Taxpayer incurred the Federal Court Legal Expenses to enable him to return to work in the stockbroking/financial services industry, the operative ASIC banning order having the effect of prohibiting the Taxpayer from “providing any financial services for a five year period”, making his authorisations as an AR of IOC “void” under the Corporations Act and “terminating” his position as an AR for IOC. The Taxpayer incurred the expenditure for the purpose of having the ASIC banning order lifted so that he could return to work, providing financial services as an AR, in the stockbroking/financial services industry – whether that be for IOC or another stockbroking firm/financial services provider with an AFSL. The Taxpayer’s reason for incurring the Federal Court Legal Expenses is analogous to the abovementioned Tribunal cases, where, in each case, the reason the legal expenses were incurred was essentially to defend the taxpayer’s registration to practice a profession (or, more particularly, in this case, to challenge the Taxpayer’s authorisation to provide stockbroking/financial services as an AR in the financial services industry generally). Such expenses are non-deductible under s 8-1(2)(a) of the ITAA 1997 as they relate to the profit-yielding structure and are “capital” in nature: refer to the case law set out in paragraphs 71 and 72 above.
Deductibility of Criminal Charges Legal Expenses
The Tribunal’s view is that the most likely “occasion” of the incurring of the Criminal Charges Legal Expenses by the Taxpayer was to avoid the penal consequences that might follow if convicted of the insider trading offences under s 1043A(1) and (2) of the Corporations Act, being potential imprisonment for up to 10 years or a substantial fine. That “occasion” is not to be found in the Taxpayer’s position as an AR or stockbroker in the financial services industry, positions that he had ceased to occupy by the time the Criminal Charges Legal Expenses were incurred by him. The “occasion” of the Criminal Charges Legal Expenses is not found in what is productive of the Taxpayer’s actual or expected assessable income: Ronpibon Tin NL, Payne, Day, Spriggs and Anstis. Rather, the relevant “occasion” was the criminal charges themselves. As such, there is an insufficient “connection” (“link” or “nexus”) between the Criminal Charges Legal Expenses and the production of assessable income by the Taxpayer: refer to the cases set out in paragraph 47 above. Accordingly, the Criminal Charges Legal Expenses are not, in the Tribunal’s opinion, deductible under the first positive limb in s 8-1(1)(a) of the ITAA 1997.
Even if the Tribunal had not reached this finding, it would nevertheless find the Criminal Charges Legal Expenses to be non-deductible expenditure of a “private” nature under s 8-1(2)(b) of the ITAA 1997. The reasons for this are as follows.
As stated, the consequence for the Taxpayer of the criminal charges for insider trading, if proven, was the imposition of penal sanctions – possible imprisonment or a fine. The Criminal Charges Legal Expenses, therefore, had the “essential character” of being expenditure incurred by the Taxpayer to prevent him from suffering adverse personal consequences, namely potential imprisonment for up to 10 years or a substantial fine. Consequently, they are to be properly characterised as expenses of a “private” nature: see Healy v Commissioner of Taxation [2013] AATA 281 [116].
It is irrelevant that the criminal charges arose out of the Taxpayer’s prior provision of stockbroking/financial services as an AR in the financial services industry, as the criminal law applies irrespective. It is the duty of every citizen of the Commonwealth to comply with criminal proceedings. It follows that the Criminal Charges Legal Expenses are essentially “private” in nature and cannot be deducted pursuant to s 8-1(2)(b) of the ITAA 1997.
DECISION
For the above reasons, the Tribunal affirms the Objection Decision.
I certify that the preceding 78 (seventy eight) paragraphs are a true copy of the reasons for the decision herein of Senior Member C R Walsh.
..(Sgd) T Freeman...........
Associate
Dated 4 November 2013
Date of hearing
17 September 2013
Date final submissions received
11 October 2013
Counsel for the Applicant
Ms L B Price
Representative for the Applicant
Mr W Tieleman
MKT – Taxation Advisors
Counsel for the Respondent
Mr J C Vaughan
Solicitor for the Respondent
Mr T P Burrows
Australian Government Solicitor
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